Unity Software (NYSE:U) is the company behind the popular Unity game development engine. Although the gaming industry continues to grow well, Unity shares have fallen by nearly 7% over the last 12 months so is Unity Software a buy after its decline, or does the stock still look too risky to be worth putting money into?
Unity’s Share Price Has Tumbled But Profitability?
The poor share price record of U over the last 12 months has been closely linked to a decline in Unity’s revenues. In each of the last five quarters, Unity revenues have shrunk on a year-over-year basis.
Annual revenues peaked at $2.19 billion in 2023 but slumped to $1.81 billion in 2024. The top line retreated again in Q1 with quarterly revenues of $435 million versus $460 million in the year-ago period.
Management has also struggled to achieve GAAP profitability. In Q1, for example, they reported a net loss of $78 million, or $(0.19) per share. While this was a considerable improvement from the $291 million the company lost in Q1 of 2024, it has lost money in every quarter during its public history.
This begs the question of how long investors will have to wait to see positive earnings from Unity and how much profit the company will be able to deliver once it finally hits that point?
Some of Unity’s non-GAAP measures, however, show a more appealing side of the company. Adjusted EPS, for example, came in positive for Q1 at $0.24. Free cash flow for the quarter was also mildly positive at $7 million. Even so, the decline in revenues and the fact that Unity hasn’t been able to deliver positive net income on a GAAP basis is somewhat worrisome.
Unity also still has a strong cash reserve at $1.54 billion, up from $1.52 billion at the end of the prior quarter. With only $817.6 million in current liabilities, this puts Unity in a decently strong near-term financial position. Though it still has over $2 billion in long-term debt, it has also been able to reduce its debt load quite a bit from the highs it reached in 2022 and 2023.
What About Valuation?
By many standards, Unity looks fairly expensive for a company that isn’t actively generating positive net income. The stock is trading at 4.8x sales and 29.4x operating cash flow.
With revenues trending downward, this could very easily leave U shares overpriced, particularly if the company can’t make swift progress toward profitability.
This seemingly high valuation hasn’t stopped analysts from assigning an even higher premium to shares of U. The consensus price target for the stock is currently $25.84, implying a gain of about 20% from the last price of $21.54. Even with this upside expectation, though, the consensus rating on Unity is still a hold rather than a buy.
Does Unity Still Have a Moat?
Unity’s software has a market share of over 25% whereas the widely popular Unreal Engine’s market share is much lower at around 15%.
Unity has, however, had to navigate a challenge of its own making that briefly made it less popular among developers. In September of 2023, the company started charging developers on a per-install basis once they had reached a revenue threshold. Last year, the company’s new CEO canceled that fee, reverting Unity to its more traditional subscription-based pricing model.
The decision to change its fee structure cost Unity dearly, contributing to its sharp revenue declines but the engine remains extremely popular, and the reversion to a more traditional pricing model will likely go a long way toward keeping developers on its platform.
As such, it’s fair to say that Unity still has a moat but that the moat sustained some unnecessary damage when the company tried to change its pricing structure.
Where Does Unity Go From Here?
Looking forward, management expects revenue of $415 million to $425 million in Q2, setting the company up for another probable quarter of revenue reduction.
Adjusted EBITDA is also expected to fall to the range of $70 million to $75 million, down from $84 million in Q1. While management seems to be keeping expectations reasonable, Unity could still be facing continued difficulties in the short run.
Going forward, Unity’s new AI-powered advertising engine, Vector, is expected to be a major growth driver for the company. By using advanced AI to deliver high-performance ads on games, Unity could see its revenue growth resume and gain access to a high-margin business line that could push it toward profitability.
The problem, however, is that this turnaround strategy is still largely unproven, leaving investors with little certainty around how much growth Vector can generate for Unity.
Is Unity Software a Buy Now?
Although Unity has a strong market position and deep popularity among game developers going for it, the stock doesn’t look like a particularly appealing investment at the moment.
With revenues still dropping and GAAP profitability still elusive, the company looks as though it could be in for a difficult period. The stock also doesn’t seem to present any huge bargains when it comes to price, introducing the possibility that investors could be paying too much for Unity at the expense of other investment opportunities.
With all of this said, Unity may be a company to watch thanks to its moat in game development. If management can turn the trend of receding revenues around, the company could be worth a second look. For now, though, U probably isn’t attractive enough to buy. Much will hinge on the success of Vector, but it could take some time for investors to form a clear picture of how much the new ad delivery platform will boost Unity.
The author has no position in any of the stocks mentioned. Financhill has a disclosure policy. This post may contain affiliate links or links from our sponsors.
